Why we Need the Bailout

First I want to recognize Chris for all of the research he put into this post, thank you. I also want to thank LaterSkater for your forwards and and a preemptive thank you for helping me not to assault the English language with my grammar.

I think there are a lot of questions out there centering on why we need a bailout and ‘why can’t we let the market sort all of these things out’? I realize this is an extreme analogy, but that would be similar to letting cancer work itself out. The prime requirement for a capitalist society isn’t having access to every market, low taxes or little regulation. The most important thing in a capitalist society are functioning capital markets and that is what the crisis we are currently facing is about.

There are several reasons why we are currently in this financial crisis and I try to address some of them in an earlier post. The point is we will have plenty of time to assign blame and credit later but for now we need to act. In the future I will make a post detailing how Marx predicted wild market swings would be the impetus to societies becoming communist, something we all want to avoid. Swings like this have largely been avoided throughout our history due to a tradition of government intervention dating back to Alexander Hamilton. The belief that the proposed intervention is an affront to American ideals and traditions is not supported by our history.

Why We Need IT

The reason we need the bailout is because credit markets have “locked up”. What does that mean….

Nobody wants to loan anybody any money (1)

Businesses need overnight money to make payroll (short term credit/ lines of credit) and they are having trouble getting them now (1)

The failure of Lehman has caused banks to be reluctant to lend money to each other (4)

The $586 Billion in credit losses has banks scrambling to restore their capital (4)

If banks are unwilling to lend to each other — as surging LIBOR rates suggest — they sure aren’t going to lend to consumers or businesses (7)

Without access to credit business will not be able to make payrolls, fund needed projects, purchase raw materials for manufacturing cover their cash flow while they wait for projects to close, etc. Even if companies are able to get access to credit at higher premiums they will need to cut costs just to maintain their performance. This generally manifests itself in the form of massive layoffs, which in turn hurts the economy since the unemployed tend to spend less. Most companies are leveraged (as they should be) and have some level of revolving debt. If this debt is coming due and they need to issue new debt their operating costs just went up. This again leads to less investment and more layoffs.

I think there is a misconception that this crisis is primarily about helping the financial sector, which it is also intended to do. However every capital intensive organization is being affected by this, especially manufacturing, information technology and municipal / state governments. The credit crisis is coming up on a year old, lets look at some specific example of how it is affecting the economy:

Because of this tightness in the market for tax-free municipal bonds, Kent County, Mich., where Grand Rapids is located, will pay some $750,000 more than it expected in interest on a $15 million, 10-year refinancing bond it sent to market earlier this week, according to county treasurer Kenneth D. Parrish.(11)

Matt Fabian, managing director of the research firm Municipal Market Advisors, said the problems extend throughout the municipal bond market, where the borrowing rate for seven-day debt spiked from 1.8 percent to 5.15 percent last week. (11)

For the week through September 20, fresh claims for unemployment benefits jumped sharply to 493,000, the Labor Department reports. (12) The last time initial claims were reaching so close to the 500,000 mark was September 2001. (13)

Home prices fell about 6% in 2007 and are expected to tumble another 15% in 2008, 10% in 2009 and 5% in 2010 (15)

The credit markets are seizing up and the uncertainty recently drove up short-term interest rates for municipalities and some rock-solid institutions such as New York’s Metropolitan Museum of Art to 20%.(15)

Compared to a year ago Caterpillar will pay about $15.6 million more per year to borrow the same amount (17)

Compared to just six weeks ago Caterpillar is going to be paying an additional 150 basis points for a similar debt instrument(16)

Caterpillar actually got a great deal because the average premium that A-rated corporate borrowers have been required to pony up has jumped 331 basis points from last year (17)

Student loans made to parents through the Parent PLUS program have plummeted — down 29% in dollar volume year (18)

Bank of America is declining to increase lending to McDonald’s franchisees even though the two companies have a long-standing partnership (18)

In August, 67% of small-business owners said they’d been affected by the credit crunch (18)

Who Ultimately is Being Affected

Investors or anyone who has a 401(k), etc/ Obvious reasons (10)

Students looking for student loans and parents looking to get them loans(10)

Anybody with Credit Card debit / Most CC rates are based on LIBOR plus a figure. LIBOR has been soaring (10) (18)

Anybody looking to buy a car / People are having challenges getting financed unless you have impeccable credit. (10)(18)

People looking to buy a house (10)(18)

Anybody looking to start a business

Anybody running a business who needs money to cover payroll until money comes in

People with ARMs that will be adjusting / They are often based on LIBOR which is soaring

Homeowners / additional foreclosures will drive down their home values

Taxpayers / Higher borrowing costs for local and state government will result in a need to either cut services or raise taxes

Even with the bailout the economy is going to get worse before it gets better. The damage that has been done is probably going to take a couple years to finish working it’s way out. The next shoe to drop is going to be large dip in consumer spending which should push the economy further down in a recession. The question do we want to face both problems at once.

I live for comments, feedback and forum posts so please let me know you thoughts on this post. If you think this is a worthwhile post don’t forget to add it your social networking site listed when you click the ‘bookmark’ button.

Very interesting article. My sis and I were discussing the point of “why a bailout is needed”. Her stance was “when the building is burning, don’t figure out who is to blame; just put out the fire and figure out everything else later.” I didn’t disagree but I will admit that since I’ve gotten rid of credit cards since April 2008 **and** I haven’t had any serious emergencies, I’m cautious about throwing money at what has become very bad spending (and saving) behavior in our culture….myself included. Something needs to be done…definitely. I’m not rich by any means and it wouldn’t take much of a financial emergency before I would consider working at “any” job to keep a roof over my head and put food on the table.

However, having said that, the only thing that’s changed for me is my spending and saving habits. I’m am a “gadget freak” and could find something to buy everyday & all day at a computer store. So, I’ve recognized that I had to “put up, or shut up” by going to a cash system….yes, I’m a Dave Ramsey (daveramsey.com) follower and for the first time in my 40+ years of living, I’ve saved more money and paid off more personal debt in 5 months than I’ve done in my entire life/professional career.

So, my long-winded story is a bail-out is great but unless folks change their spending and saving behaviors, history will repeat itself and all the bail-outs in the world won’t fix that. I question what is going to be done on the grander scale to solve the issues involving government spending (banks, etc) to the worker-bees of America.

You’ve put together a lot of good info on the Bailout. I agree with you about the problems you’ve cited but I still don’t think that this bailout that was passed is what the problem called for. Instead it was a kneejerk reaction to a long ignored problem (if you can count creating the problem and fueling it’s flames as ignoring it).

It’s my belief that the bailout will only prop up broken policy and bad business. My concern is that excessive government intervention will only drag the propblem out, much like price controls and other bad policy extended the downturn that was the Great Depression.

Many people talk about how we have to change how we (us citizens, well and the government) spend money. If the government creates artificial controls and prints money on a whim to discourage us (and business) from doing so, how can we reach that point of better spending? I don’t think we should go cold turkey and just let everything work itself out though.

Here are some of the things I would have liked to have seen in the reactionary legislation to the current economic crisis… http://blog.mises.org/archives/008677.asp. These suggestions directly affect problems in the banking industry.

In my opinion though, the most disgusting part of the bailout was the massive amount of pork that was attached the bailout. The government still hasn’t realized that they too need to curb spending on unnecessary programs. Our national debt is outrageous. We just added more than a trillion to that number with this bailout and Fanny/Freddy/AIG. What happens when instead of Lehman’s going bankrupt, the United States does?

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